Foreign capital is again surging into Indian markets, exciting opinion as to its drivers. One set regards it a ‘hope’ rally, founded in optimism about a new, stable government in mid-May; others ascribe it to stabilising policy actions that improved fundamentals, making India far more attractive relative to peers. Whatever be the reason, the point for policy attention is that a $5.2 billion of inflow last month lifted the rupee 3.1% over its end-February value. Considering the rupee traded in the R61-62 range in the five months to March, this is a sharp appreciation in a short time. Several questions arise. Inter alia, why did the Reserve Bank of India (RBI) allow such appreciation? What does this signify from an exchange rate policy perspective? Should not RBI clarify sooner than later to ward off build-up of expectations in several quarters? Is there a danger of repeating past policy errors in managing capital inflows?

Reserves rose by some $4 billion in March. But according to RBI, this was because inflows were augmented by repayments by oil companies in lieu of their past obligations to the central bank. Coupled with that, a mere $5 billion of capital inflow tossed up the rupee by 3%, the movement suggests RBI purchased little foreign currency.

That’s surprising, if only looking at the $32 billion build-up in the central bank’s forward book. Why exactly did RBI allow the currency to drift up so fast and against fundamental considerations? Markets largely consider the rupee fairly valued at R60-61 to the dollar, the same as assessed by the finance ministry not so long ago, while the most recent estimation by the IMF—based on data available as of November 2013, using three different methods—evaluated the “…exchange rate…slightly above levels that can be explained by underlying fundamentals (trading range vis-à-vis the dollar was R62-63 then).

A month is too short a time to gauge policy direction, especially when it is March in India. Maybe the short-term context of market liquidity militated against intervention: the government added R160 billion to the market by its bond buybacks in lieu of cash surplus. Given the peculiar situation, RBI could have been wary to purchase foreign currency and add to this surfeit as overnight interest rates would have collapsed—at 7.05-7.5% in the last week, these were weak enough. It may have worried about easier policy signals, an inconsistency with its monetary stance and damaging its anti-inflationary credentials: